How do auto liquidations due to price volatility work for loans?Last Updated: May 26, 2019
Every loan has a Safe Region, Critical Region and a Hard Stop. A loan in Safe Region cannot be auto-liquidated while a loan in Critical Region can be liquidated by one of the multiple workers tracking active loans in order to liquidate them. Hard Stop denotes the final point after which the borrower will lose more collateral than he committed once the loan stops.
Critical region for a loan is defined by the following inequality.
(100 + premium + buffer) * loanAmount / (100 * collateralAmount) >= collateral_currency_price / loan_currency_price
Buffer is set at 10% for loans system-wide.
A loan with 20ETH collateral and 0.5x leverage is placed at 1% premium for 1 week. DAI is the loan currency.
The loan was placed using best rates on partner exchanges in realtime such that
collateral amount = 20ETH,
loan amount at 0.5x leverage = 3000DAI (@300DAI/ETH)
Lets look at 2 instances in time to see if an auto-liquidation would be triggered. Using above inequality (currency prices are with respect to DAI), we get:
T1: 1ETH = 250DAI
=> (100 + 1 + 10) * 3000 / (100 * 20) >= 250 / 1
=> 166.5 >= 250
T2: 1ETH = 160DAI
=> (100 + 1 + 10) * 3000 / (100 * 20) >= 160 / 1
=> 166.5 >= 160
T1 represents a loan is Safe Region and wont be liquidated while T2 represents a loan in Critical Region and will be liquidated by workers.
10% buffer prevents lenders from losing money in a volatile market by pushing a loan in critical region for on-chain liquidations to happen just before prices drop to the hard stop. Buffer is market dependent and can increase with increasing volatility in crypto markets.